Yes, contributions made to a traditional pre-tax 401k are tax deductible. The amount you contribute gets deducted from your taxable income for the tax year. For 2023, it’s possible to deduct up to $22,500 ($30,000 if age 50+) in taxable income through 401k contributions.
However, it’s important to note that contributions made to a Roth 401k are not tax deductible. Only contributions to a traditional 401k get deducted from your taxable income. Not all, but some 401k plan providers will offer participants two different account options: a traditional 401k and a Roth 401k. Only contributions made to a traditional 401k are tax deductible.
Traditional 401k: Contributions are made with pre-tax income and get deducted from your taxable income for the year. Withdrawals in retirement get taxed as regular income.
Roth 401k: Contributions are made with post-tax income and you do not get any tax breaks on your contributions. However, withdrawals in retirement are completely tax-free.
How much can I deduct through 401k contributions?
The maximum amount you can deduct from your taxable income is $22,500 ($30,000 if age 50+) for 2023.
As an employee receiving an employer-sponsored 401k plan, you can contribute up to 100% of your income up to $22,500 for 2023, or up to $30,000 if you’re at least 50 years of age. You will receive a tax deduction for however much you contribute.
For example, let’s pretend you made $100,000 in income as an employee, and decide to contribute $20,000 into your 401k plan. If you make the contribution to your traditional 401k, the contribution amount will be tax deductible. Your new taxable income for the year will be $80,000. You get to contribute the full pre-tax amount into your 401k plan, and pay less taxes for the year. The tradeoff is that withdrawals in retirement will get taxed as regular income. On the other hand, if you contribute to the Roth 401k instead, your taxable income will still be $100,000. You’re paying taxes upfront now in return for tax-free withdrawals in retirement.
Also read: 401k Contribution Limits & Deadlines
How much does a 401k contribution reduce taxes by?
To figure out the dollar value of taxes saved from your 401k contribution, you’ll have to figure out your marginal tax rate (tax bracket) and multiply it by your contribution amount. For example, if you contributed $20,000 to your 401k this year and your marginal tax rate is 24%, then you would avoid paying $4,800 in taxes.
How much do I need to make to max my 401k contributions?
The 401k contribution limit for employees is up to 100% of compensation up to $22,500 for 2023, or up to $30,000 if age 50+. If you’re under 50 years of age, you technically would only need to make $22,500 in pre-tax income to maximize your 401k contributions as an employee. If you’re over 50 years of age, you would need to make $30,000 in pre-tax income to maximize your 401k contributions.
How do I report 401k tax deductions to the IRS?
There’s no need to report 401k tax deductions to the IRS since they’re already automatically deducted from your taxable income. For example, if you made $50,000 this year and contribute $20,000 into your traditional 401k, your employer would report your taxable income as $30,000 to the IRS.
Can I also contribute to an IRA at the same time?
Yes, even if you max out your 401k contributions, you can get further tax deductions by contributing to a traditional IRA. The contribution limit for an IRA in 2023 is $6,500 or $7,500 if age 50+. Like your 401k contributions, your IRA contributions will also get deducted from your taxable income for the year.
To get the full tax deduction on your IRA contribution, your modified adjusted gross income must be $73,000 or less.
Traditional IRA tax deduction limits for 2023
- If your MAGI is $73,000 or less, you get get a tax deduction up to the maximum traditional IRA contribution limit of $6,500 ($7,500 if age 50+).
- If your MAGI is over $73,000 but less than $83,000, you’ll get a partial tax deduction.
- If your MAGI is over $83,000, you get no tax deduction.
To be able to get the full tax-deduction on your contributions for 2023, your income must be under $73,000. You’re still allowed to make contributions into a traditional IRA even if your income is too high but you get no tax deductions.
Withdrawals from a tax deductible 401k
Because contributions to a traditional 401k are made with pre-tax dollars (income you haven’t paid any taxes on), you’ll be required to pay regular income taxes when you start taking qualified distributions from your 401k plan. You can start taking withdrawals from your 401k when you reach the age of 59½. Withdrawals made before the age of 59½ will be hit with a 10% penalty plus income taxes. Withdrawals made after the age of 59½ will not have the 10% penalty, but you’ll still be required to pay regular income taxes.